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The GEO Group [NYSE:GEO - $19.15] is a world leader in providing private corrections and detention management, health, and mental health services to federal, state and local government agencies. With operations in the US, Australia, Canada, Cuba, South Africa, and the United Kingdom, GEO offers high-quality and cost-effective services with state-of-the-art designs, innovative programs and ground-breaking treatment approaches.

GEO’s turnkey solutions include:

  • Facility Management
  • Facility Operation
  • Facility Maintenance
  • Facility Design
  • Infrastructure Financing
  • Construction Management
  • Residential/Special Needs Services
  • Secure Prisoner Escort
  • Court and Immigration Custody Services

Founded in 1984, GEO now manages 61 facilities encompassing approximately 60,000 beds world-wide. Over 13,000 professionals supervise care of the 60,000 plus individuals assigned to their custody on behalf of federal, state, and local government agencies. GEO provides expertise in facility design, financing, contract compliance, risk management, general administration, security, health services, human resources, information technology, basic education, vocational training, counseling, substance abuse treatment, mental health services, special needs populations, food service, and facility maintenance.

Crime, unfortunately, is a growth industry and GEO Group has proven to be a successful player in the outsourcing trend for governments at many levels. Over the past 10 years EPS more than quadrupled (from $0.31 to $1.28) while revenues per share climbed by 160%. Book value increased from $2.02/share in 2000 to $12.87 at year-end 2009 due to a combination of retained earnings and a well-timed secondary offering in 2007 when the shares were near all-time highs.

Here are GEO’s per share (split-adjusted) numbers (excluding nonrecurring items) as reported by Value Line:

Year
Sales
C/F
EPS
B/V
Avg. P/E
2000
8.50
0.45
0.31
2.02
8.8x
2001
8.93
0.47
0.30
2.07
13.4x
2002
8.92
0.53
0.34
2.39
13.7x
2003
22.06
0.70
0.12
3.11
43.4x
2004
21.55
1.12
0.60
3.50
11.9x
2005
21.08
0.75
0.20
3.74
44.7x
2006
21.80
1.33
0.85
6.29
15.4x
2007
20.10
1.48
0.84
10.35
31.4X
2008
20.40
1.93
1.19
11.32
19.0X
2009
22.10
2.04
1.28
12.87
13.9X

The relatively tight consensus views for 2010 and 2011 are now centered on $1.41 and $1.55 respectively. That puts the current multiple at < 13.6X this year’s and under 12.4x the 2011 expectations.

The only previous times GEO traded at lower annual multiples was in 2000 and 2004. Investors who bought shares near the 2000 low saw an 18-month surge from a split-adjusted $2 to $5.80 from 2000 – early 2002. Those who picked up shares in 2004 near the $5.70 low were treated to a double in less than one year and an eventual move to an overvalued price of $32.90 in 2007.

The ultra-high P/Es of 2003 and 2005 were the result of low earnings rather than high market expectations and are not meaningful. Value Line is using a 17 normalized multiple in figuring their 3-5 year projections. Even a 16 P/E on this year’s estimate would bring these back to $22.56 or plus 17.8% above this afternoon’s quote.

That target seems quite conservative as GEO has actually traded at $23.18 already this year and has exceeded $22.75 during each of the most recent four calendar years.

The shares look good for 15% - 20% gains by year-end as a straight purchase.

Here’s a nice buy/write combination play that appears even better…

Cash Outlay
Cash Inflow
Buy 1000 GEO @ $19.15 /share
$19,150
Sell 10 Sep. $20 Calls @ $1.30 /share
$1,300
Sell 10 Sep. $20 Puts @ $2.05 /share
$2,050
Net Cash Out-of-Pocket
$15,800

If GEO shares creep up to $20 (+ 4.5%) or higher by September 17, 2010:

· The $20 calls will be exercised.

· You will sell your shares for $20,000.

· The $20 puts will expire worthless.

· You will have no further option obligations.

· You will end up with no shares and $20,000 in cash.

That best-case scenario would result in a cash-on-cash profit of $4,200 / $15,800 = 26.5% achieved in just six months on shares that only needed to rise by at least 4.5%.

If GEO shares finish below $20 on the September 17, 2010 expiration date:

· The $20 calls will expire worthless.

· The $20 puts will be exercised.

· You will be forced to buy an additional 1000 GEO shares.

· You will need to lay out another $20,000 of cash.

· You will end up with 2000 GEO shares.

What’s the break-even on the whole trade?

On the original 1000 shares it’s their $19.15 /share purchase price less the $1.30 /share call premium = $17.85 /share.

On the ‘put’ shares it’s the $20 strike price less the $2.05 /share put premium = $17.95 /share.

Your overall break-even price becomes $17.90 /share or 6.5% below the trade inception price.

Summary:

GEO shares look good for a 15 – 20% move over the next 9 -12 months.

Those who understand and are comfortable with writing (selling) options should consider buying shares and selling the $20 calls and puts with the September 2010 expiration date. Any move of 4.5% or better will translate into a 26.5% cash-on-cash profit over the six-month time horizon of this trade.

You have a built in 6.5% margin of safety as GEO shares could decline by up to $1.25 /share without causing a loss on the trade.

Disclosure: Author is long GEO shares and short GEO options.

Source: GEO Group: Where Delinquencies Make for Good Business